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Sarbanes-Oxley: Auditor Independence (Portfolio 5502)

This Portfolio 5502 Sarbanes-Oxley: Auditor Independence, presents a detailed study of the requirement that an accountant auditing the financial statements of a public company must be independent in fact and in appearance of that company.

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DESCRIPTION

This Portfolio 5502 Sarbanes-Oxley: Auditor Independence, presents a detailed study of the requirement that an accountant auditing the financial statements of a public company must be independent in fact and in appearance of that company. This Portfolio analyzes the historical auditor independence rules under the U.S. securities laws, the changes to these rules as a result of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), and the reasons for these changes. Because the Public Company Accounting Oversight Board (the “PCAOB”) is responsible for implementing the Sarbanes-Oxley Act, the Portfolio also includes a general discussion of the establishment, purpose, and operation of the PCAOB.
Section I provides historical information regarding auditor independence. It discusses the Regulations issued by the Securities and Exchange Commission (“SEC”) on auditor independence predating the Sarbanes-Oxley Act and the events leading to that legislation.
Section II describes the regulation of the public accounting profession, a subject inextricably intertwined with auditor independence. After summarizing the profession's long history of self-regulation, Section II describes the structure and operation of the PCAOB and related topics including oversight and funding.
Section III discusses the categories of services that an accounting firm cannot provide to an audit client without impairing independence and the categories of services that can be provided if pre-approval is obtained from the audit client's audit committee.
The remaining sections of the Portfolio discuss other topics pertinent to the overall subject of auditor independence. These topics include rotation of audit partners, communications between accounting firms and audit committees, and relationships between accounting firms and audit clients. Worksheet 1 provides a Glossary of significant terms used in the Portfolio, and other worksheets illuminate the Detailed Analysis.
This Portfolio may be cited as BNA Tax and Accounting Portfolio 5502, Henkel, Wheeler, and Lane, Sarbanes-Oxley: Auditor Independence (Accounting Policy and Practice Series).


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AUTHORS

MICHELLE M. HENKEL, ESQ.
Michelle M. Henkel; B.A., Rhodes College (1986); Senior Accountant, Arthur Andersen & Co. (1986-1989); Manager, National Mortgage Co. (1989-1990); J.D., Emory University School of Law (1993); Federal Tax Controversies, Mayer, Brown, Rowe & Maw (Associate, 1993-1994); Federal Income Tax, Alston & Bird LLP (Associate, 1994-1999; Partner, 2000-present); Member, American Bar Association (Section of Taxation, Banking and Savings Institution Committee, and Court Practice and Procedure Committee); Vice-Chair, Banking and Savings Institution Committee of the American Bar Association's Section of Taxation (2005-2007); Member, Tax Audits and Litigation Committee of the District of Columbia Bar (2005-present); Chair, Section of Taxation of the Atlanta Bar Association (2005-2006); Member, Atlanta Tax Forum (2001-present); Trustee, Thompson West Tax Advisory Board (2003-2005); Member, American Institute of Certified Public Accountants (1986-present); Member, Georgia Society of Certified Public Accountants (1996-present); Admitted to the bars of the District of Columbia, Georgia, and Illinois; Admitted to practice in the U.S. Supreme Court, the Eleventh and Federal Circuit Courts of Appeals, the U.S. Tax Court, the U.S. Court of Federal Claims, the Court of Appeals for the District of Columbia, the Supreme Court of Georgia and the Supreme Court of Illinois; Licensed as a certified public accountant (Tennessee; inactive status); Author and speaker on federal tax and tax controversies topics.

CHARLES W. WHEELER, ESQ.
Charles W. Wheeler; B.A., University of Wisconsin (1967); J.D., University of Wisconsin (1970); LL.M., Georgetown University (1978); Senior Tax Counsel, U.S. Chamber of Commerce (1979-1981); Assistant to the Commissioner of Internal Revenue (1981-1983); Tax Counsel, American Bankers Association (1984-1986); Partner, Ernst & Young, LLP (1986-1994); Partner, KPMG, LLP (1994-1999); Partner, Federal Income Tax, Alston & Bird LLP (1999-Present); Member, American Bar Association (Section of Taxation); Chair, Banking and Savings Institutions Committee of the Tax Section of the American Bar Association (1991-1993); Primary author of the Bank Income Tax Return Manual (1987-1994); Co-author of Taxation of Financial Institutions; Author and speaker on financial industry and financial product tax issues; Admitted to the bars of Wisconsin and the District of Columbia; listed in The Best Lawyers in America.

ANDREA M. LANE, ESQ.
Andrea M. Lane; B.S. Acc., University of Florida; J.D., The George Washington University Law School; LL.M., New York University School of Law; Associate, Alston & Bird LLP (2001-present); Member, American Bar Association (Section of Taxation); Co-author of articles appearing in the Journal of Taxation, the Journal of Financial Instruments and the International Tax Review; Admitted to the bars of Virginia and the District of Columbia; Licensed as a certified public accountant in Virginia.

TABLE OF CONTENTS

Detailed Analysis

I. Background

Introductory Material

A. The Role of Independence in the Auditing Process

B. The Role of the Independent Auditor as the "Public Watchdog"

C. Regulation S-X

1. Adoption of Regulation S-X

2. Modernization and Strengthening of Regulation S-X

3. Structure of Regulation S-X

a. Preliminary Note

b. Rule 2-01(a): State Law Qualification

c. Rule 2-01(b): General Standard

d. Rule 2-01(c): Specific Circumstances

D. Events Leading Up to Legislative Action

E. Enactment of the Sarbanes-Oxley Act

II. Regulation of the Public Accounting Profession

Introductory Material

A. Self-Regulation of the Accounting Profession

1. Stimulus for Self-Regulation

2. The SEC Practice Section and the Public Oversight Board

a. Organization and Operation

b. Peer Review Program

c. Quality Control Inquiry Committee

3. The Independence Standards Board

4. Expansion of the Public Oversight Board's Authority

5. Dissolution of the Independence Standards Board

6. Termination of the Public Oversight Board

7. Status of the AICPA's Regulatory Programs After the Sarbanes-Oxley Act

B. Public Company Accounting Oversight Board

1. Establishment and Structure of the PCAOB

a. Formation of the PCAOB

b. Membership of the PCAOB

c. Ethics Code for Members and Staff of the PCAOB

2. Operation of the PCAOB

a. Authority of the PCAOB

b. Duties of the PCAOB

(1) Registration System

(2) Professional Standards

(a) Interim Standards

(b) Auditing and Quality Control Standards

(c) Ethics and Independence Standards

(d) Conforming SEC Amendments

(e) Additional Studies

(3) Inspections

(4) Investigations and Disciplinary Proceedings

c. Annual Reporting by the PCAOB

d. Foreign Public Accounting Firms

3. Supervision and Oversight of the PCAOB

4. Funding of the PCAOB

III. Scope of Services Provided by Accounting Firms

A. Overview

B. Prohibited Non-Audit Services

1. Bookkeeping Services

2. Financial Information Systems Services

3. Appraisals or Valuation Services, Fairness Opinions, or Contribution-In-Kind Reports

4. Actuarial Services

5. Internal Audit Outsourcing Services

6. Management Functions

7. Human Resources

8. Broker-Dealer, Investment Advisor, or Investment Banking Services

9. Legal Services

10. Expert Services

11. Special Situations and Prohibited Non-Audit Services

a. Successor Auditors

b. Translation Services

c. Employee Benefit Plans

C. Tax Services

1. Permissible Tax Compliance, Tax Planning, and Tax Advice Services

2. Restrictions Imposed by PCAOB's 2005 Rules

a. Restrictions on Tax Shelters and Marketed Tax Products

(1) Confidential Transactions

(2) Aggressive Tax Positions

b. Restrictions on Tax Services to Certain Audit Client Employees

(1) Audit and Professional Engagement Period

(2) Exceptions to Prohibited Tax Services

D. Contingent Fees

1. Regulation S-X

2. PCAOB's 2005 Rules

E. Pre-Approval of Audit and Non-Audit Services by Audit Committees

1. General Rule

2. Methods of Pre-Approval

3. Waiver of Pre-Approval Requirement

4. Delegation of Pre-Approval Authority to Subcommittee

5. Disclosure of Non-Audit Service Approval

6. Special Rules for Investment Companies

7. PCAOB's 2005 Rules for Pre-Approval of Tax Services

F. Disclosure of Audit and Non-Audit Services

1. Disclosure Rules Prior to the Sarbanes-Oxley Act

2. Expanded Disclosure Rules After the Sarbanes-Oxley Act

3. Categories of Fees Paid to Accounting Firms

4. Disclosures Relating to Pre-Approved Services

5. Audit Hours Attributable to Other Accountants

6. Special Rules for Investment Companies

IV. Rotation of Accounting Firms and Their Audit Partners

A. Audit Firm Rotation

B. Audit Partner Rotation

1. AICPA's Rules Prior to the Sarbanes-Oxley Act

2. Modification of the Rules by the Sarbanes-Oxley Act

3. Mechanics of the Rotation Rules

a. Lead and Concurring Audit Partners

b. Other Audit Partners

4. Small Firm Exception

5. Special Rule for Registered Investment Companies

6. Special Transition Rules

V. Communication Between Accounting Firms and Audit Committees

A. Communication Requirements Under GAAS

B. Codification of Communication Requirements

1. Critical Accounting Policies and Practices

2. Alternative Accounting Treatments

3. Other Material Written Communication

4. Form and Timing of Communication

C. PCAOB's Interim Independence Standards for Audit Committees

VI. Relationships Between Accounting Firms and Their Audit Clients

Introductory Material

A. Financial Relationships

1. Prohibited Investments in Audit Clients

a. Direct Investment

b. Beneficial Ownership or Control

c. Voting Trustee or Executor

d. Material Indirect Investment

e. Significant Influence

2. Other Prohibited Financial Interests

a. Loans: Debtor-Creditor Relationship

b. Savings and Checking Accounts

c. Broker-Dealer Accounts

d. Future Commission Merchant Accounts

e. Credit Cards

f. Insurance Products

g. Investment Companies

3. Exceptions to the Financial Relationship Rules

a. Unsolicited Financial Interests

b. New Audit Engagements

c. Employee Compensation and Benefit Plans

4. Audit Client's Financial Relationships

a. Investments in Accounting Firms

b. Underwriting

B. Employment Relationships

1. Employment of the Accountant by the Audit Client

2. Employment of the Accountant's Relatives by the Audit Client

3. Employment of a Former Employee of the Accounting Firm by the Audit Client

a. General Prohibition

b. One-Year Cooling-Off Period

c. Special Rule for Investment Companies

d. PCAOB's Interim Independence Standards

4. Employment of a Former Employee of the Audit Client by the Accounting Firm

C. Business Relationships

VII. Compensation of Audit Partners Based on Non-Audit Services

VIII. Quality Control Exception for Inadvertent Impairment of Independence


WORKING PAPERS

Working Papers

TABLE OF WORKSHEETS

Worksheet 1 Glossary of Terms

Worksheet 2 Historical Events Relating to Auditor Independence

Worksheet 3 Accounting Series Release No. 2 (May 6, 1937)

Worksheet 4 Regulation S-X, 17 C.F.R. § 210.2-01 (as adopted and effective on Feb. 21, 1940)

Worksheet 5 Regulation S-X, 17 C.F.R. § 210.2-01 (as amended on Nov. 7, 1942)

Worksheet 6 Regulation S-X, 17 C.F.R. § 210.2-01 (as amended on May 24, 1943)

Worksheet 7 Regulation S-X, 17 C.F.R. § 210.2-01 (as amended on Dec. 20, 1950)

Worksheet 8 Regulation S-X, 17 C.F.R. § 210.2-01 (as amended on April 8, 1958)

Worksheet 9 Regulation S-X, 17 C.F.R. § 210.2-01 (as amended on July 21, 1972)

Worksheet 10 Regulation S-X, 17 C.F.R. § 210.2-01 (as amended on March 7, 1983)

Worksheet 11 Regulation S-X, 17 C.F.R. § 210.2-01 (as amended on Dec. 5, 2000)

Worksheet 12 Regulation S-X, 17 C.F.R. § 210.2-01 (as amended on Feb. 5, 2003)

Worksheet 13 Securities and Exchange Commission Office of the Chief Accountant Application of the Commission's Rules on Auditor Independence Frequently Asked Questions

Worksheet 14 PCAOB Typical Rulemaking Process

Worksheet 15 Independence Standards Board Discussion Memorandum 99-2 Evolving Forms of Firm Structure and Organization Appendix A: Services Offered by Professional Accounting Firms October 1999

Worksheet 16 Web Sites Identified in the Portfolio

Worksheet 17 Disclosure Rules Prior to the Sarbanes-Oxley Act Example of Schedule 14A Disclosure Relating to Audit and Non-Audit Services

Worksheet 18 Disclosure Rules After the Sarbanes-Oxley Act Example of Schedule 14A Disclosure Relating to Audit and Non-Audit Services

Worksheet 19 Disclosure Rules After the Sarbanes-Oxley Act Example of Form 10-K Disclosure Relating to Audit and Non-Audit Services

Worksheet 20 Disclosure Rules After the Sarbanes-Oxley Act Example of Schedule 14A Disclosure Relating to Audit and Non-Audit Services For a Registered Investment Company

Worksheet 21 Disclosure Rules After the Sarbanes-Oxley Act Example of Schedule 14A Disclosure Relating to Audit and Non-Audit Services for a Registered Investment Company

Worksheet 22 26 U.S.C. § 267(a)-(c) Losses, Expenses, and Interest with Respect to Transactions Between Related Taxpayers

Worksheet 23 26 U.S.C. § 707(a)-(b) Transactions Between Partner and Partnership

Worksheet 24 SEC Pamphlet - Audit Committees and Auditor Independence

Bibliography

OFFICIAL

Statutes

Internal Revenue Code

Legislative History

Caselaw

Treasury Regulations

IRS Rulings

SEC Regulations and Releases:

SEC Regulations

SEC Releases

PCAOB Rules, Regulations, and Releases:

PCAOB Auditing Standards

PCAOB Rules

PCAOB Releases

Independence Standards Board:

UNOFFICIAL

Books and Treatises

Comment Letters